EC-112Current Issues in EconomicsEconomics of Education(continued)Lecture 4
The results from numerous studies of the rate of returnto a graduate education are well above 6% which hasbeen used by the Treasury in deciding whether apublic investment is appropriate.This is before making any allowance for benefits whichmay arise to the wider economy, some of which maybe difficult to quantify.However, it should be future returns rather than pastreturns which should determine an individual’sinvestment decision in a university education.Historic rates of return may be an imperfect predictionof prospective rates of return.
Future premia to a university education are likely to bedetermined by a number of factors:• growth in the supply of graduates• growth in the demand for graduates• the impact of any shift in the balance between supply anddemand on the graduate pay premium• the impact of any changes to the capability of entrants to HigherEducation• elasticity of substitution, the flexibility for profitable substituting ofgraduates with non-graduate labourTrying to forecast future labour market needs for highlyqualified workers cannot be done with any precisionGiven the recent large increase in students attendinguniversity returns may be lower that for earlier generations
However, whilst the supply of graduates is increasing,so is the demand for graduates as new technologiesare introduced and patterns of work change. There isan increasing demand for higher level of skills andforecasts expect this trend to continue.Changes in industrial structure is also likely toinfluence demand for graduates• decline in manufacturing employment which traditionally employsrelatively few graduates• increase in employment in business and finance sector whichtraditionally employ relatively large numbers of graduates
However, changes in occupational structure likely tobe more important• fewer clerical workers• more professional workersWithin all occupations demands for skills areincreasing
Social Demand for EducationSo far we have focused on the individual as the main purchaserof education. However, some of the reasons why society wantseducation are distinct from those of individuals.• Necessary for the functioning of democracy• Increase in welfare from technical progress can beimmenseEndogenous growth theory suggests the rate at which theeconomy grows will depend on the level of education undertaken• Robert Barrow finds a 10% increase in educationattainment increases growth by 0.2% per year• Becker estimated the social rate of return to education at25%
The size of these figures might explain why education isprovided by the state.But why does education have to be provided by the state.Couldn’t education not be produced by the private sector andpurchased by consumers on the free market?Education is likely to be susceptible to market failures:• Externalities• Information problems• Constraints on individual investmentsIf there were no state intervention in the market for education,individuals would enter further/higher education only if theprivate benefits of education exceed the private costs.This can be shown in the following diagram.
£pmcpmbNp No. of studentsIn this case, equilibrium number of students is given as Npwhere private marginal cost (pmc) is equal to private marginalbenefit (pmb).However, the possibility arises that social marginal costs andsocial marginal benefits may be different from the private shownabove.
As a result the private market may result in too few studentsentering higher education. Np less than Ns.A subsidy however could result in the socially optimal number ofstudents being educated – shifts pmc to the right to pmc’Capital ConstraintsCapital markets allows people to transfer wealth betweendifferent periods by borrowing and lending so that profitableopportunities for education should be fully exploited.£smcsmbNs No. of students
However, there may be severe problems for many peopledue to reluctance on the part of lenders to lend as much asindividuals might want.• Default especially a problem given the timing ofexpenditures• Long-term financing for house is possible because ahouse itself acts as a security for the loan.
SignallingCritics of human capital theory argue that education doesnothing to increase productivity, rather it signals to anemployer that an individual is talented.To be effective the screening process must separate thehigh-ability workers from others.Important to test human capital and signalling theories.Both predict that education effects earnings.What we need to know is – does education determineproductivity? Problem arises because on many occasionswe can’t observe productivity.
If schooling is purely a screening device we mightexpect that the self-employed would invest less ineducation as they are likely to know their ownproductivity so do not need to acquire signals to testifythis.There is evidence in both the USA and UK that theself-employed do acquire less schooling thanemployees.However, no perfect test as those self-employed maynot know when deciding whether or not to invest ineducation that they will become self-employed. So stillmay need to acquire a good education – the signal.
Also self-employed may need to acquire certificates asa testimony to their competence.If schooling is only a screening device would expectschooling to be less important as years with anemployer increases as they would have moreinformation on an employee – appears not to be thecase.If schooling were only a screening device wouldexpect other cheaper screens than education to comeinto existence – IQ testing stations!If education is only a screening device this woulddramatically reduce the social rate of return toeducation but not the private.